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When regulators intervene to rescue failing financial institutions, they may lead banks to expect future assistance and increase their risk-taking. To avoid incentivizing risky behavior, regulators often try to signal that they will not assist banks in a future crisis. Regulations passed during the savings and loan (S&L) crisis in the 1980s provide a rare example of policies that in fact discouraged risk-taking. After a wave of S&L failures, the Federal Savings and Loan Insurance Corporation (FSLIC) liquidated or sold some failed S&Ls but assisted others to keep them in operation. In 1989, however, the FSLIC closed. A new regulatory agency was prohibited from assisting failed institutions, which signaled the suspension of future assistance.

Padma Sharma examines how suspending assistance to failed S&Ls in 1989 affected the balance sheets of operational S&Ls. She finds that S&Ls responded to the change in policy differently depending on ownership structure: stock S&Ls increased their composition of safe assets relative to mutual S&Ls. If government assistance had remained feasible, stock S&Ls likely would have continued taking risks, lending an additional $2.14 billion and reducing their holdings of securities by $4.5 billion. In contrast, mutual S&Ls did not engage in excessive risk-taking even when government assistance was feasible, so they had little incentive to further reduce risk-taking when assistance was suspended.

Publication information: Vol. 107, no. 3
DOI: 10.18651/ER/v107n3Sharma


Padma Sharma


Padma Sharma is an Economist at the Federal Reserve Bank of Kansas City. She joined the Economic Research Department in July 2019. Prior to joining the department, she completed …